If you’re ever interested in calculating the highest possible return from a minimum amount of investment risk, you’re in the right place. In this article, I’ll demonstrate to you how to calculate Alpha in Excel. This is the term that provides you with a quantitative measurement of the returns considering the risk. This is also known as Jensen’s Alpha. I’ll show you how to calculate another type of Alpha that is Cronbach’s Alpha. I’ll explain the steps in detail so that you may use them easily whenever you need them. Now to get an overview of what we’re going to do here, you may check the following image.
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What Is Alpha?
Before diving into the details, first, let’s get introduced to the term Alpha. Alpha is an indicator to describe the possibility of getting the maximum possible return considering the risk associated. This is a measurement professionals use in their day to day life to get an idea of how well a portfolio should work taking the risk into consideration. This kind of Alpha is also known as Jensen’s Alpha. You may use it in the stock market every now and then. The formula to calculate Alpha is as follows.
There is another kind of Alpha known as Cronbach’s Alpha. This is related to a parameter that measures internal consistency. That is, the close relationship between the different parts of a system can be measured using Cronbach’s Alpha. You may use Cronbach’s Alpha to measure the internal consistency of a questionnaire
How to Calculate Alpha in Excel: 4 Suitable Examples
1. Calculate Cronbach’s Alpha in Excel
Cronbach’s Alpha is a quantitative measurement of how closely connected the components of a system are. For example, we’ve 4 questions regarding our new product. We’ve conducted a survey with these questions and now want to analyze the degree of internal connections among these questions. To analyze this, we’ve taken the responses of 10 persons to our questionnaires into consideration. Our dataset looks like this.
Now I’ll demonstrate to you how we can calculate Cronbach’s Alpha for this dataset.
- Go to Data >> Data Analysis >> Anova: Two Factor Without Replication and click on OK.
As a result, the Anova: Two Factor Without Replication window will pop up.
- Type $C$5:$F$14 in the Input Range: to populate the dataset and $B$16 in Output Range: to get the output and click on OK.
As a result, we’ll get the details of Anova: Two-Factor Without Replication data starting from cell B16.
We’ll need to use the data in cell E38 which is MS for Rows and in cell E40 which is MS Error to calculate Cronbach’s Alpha.
- Type the following formula in cell B45 and hit ENTER to get Cronbach’s Alpha. I’ve shown the formula in cell C45 using the FORMULATEXT function so that you can understand it properly.
So, we’ve got Cronbach’s Alpha value for our dataset. The value is approximately 0.89 which indicates a strong internal relationship within the questions of the questionnaires.
2. Compute Jensen’s Alpha Using Beta Calculation in Excel
Jensen’s Alpha is a measurement of the most possible return considering the risk associated with it. It is also known as Alpha. We can calculate Jensen’s Alpha for any portfolio. For example, we have the Portfolio Returns and Market Returns data for a whole year. We now want to calculate Jensen’s Alpha for this set of data. First of all, take a look at our dataset.
Now, I’ll show the step-by-step procedures to calculate Jensen’s Alpha.
We’ve Portfolio Returns and Market Returns data. We need to calculate the average of these data. We’ll use the AVERAGE function to do so.
- Type the following formula in cell C17 and press ENTER to get the Average Portfolio Returns. I’ve shown the formula in cell C18 to ease your understanding.
- Similarly, type the following formula in cell D17 to get the Average Market Returns and press ENTER.
- Type the following formula in cell C21 and press ENTER to get the Covariance.
- Similarly, type the following formula in cell C22, and hit ENTER to get the Variance.
Beta is the ratio of Covariance and Variance.
- Type the following formula in cell C23 and press ENTER to get the Beta value.
Suppose the Risk Free Rate is 1.30%. Now, we have to calculate the Expected Rate of Return. We know that the formula to calculate Expected Rate of Return is as follows.
- Type the following formula in cell C27 and hit ENTER to get the Expected Rate of Return.
Now, Jensen’s Alpha which is also known as Alpha is the difference between Average Portfolio Return and Expected Rate of Return.
- Type the following formula in cell C28 and hit ENTER to get Jensen’s Alpha.
Hence, Jensen’s Alpha is 3.40%.
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3. Calculating Alpha Using CAPM Formula
We can calculate Alpha in Excel using the CAPM formula too. CAPM stands for Capital Asset Pricing Model. The formula to calculate Alpha is as follows.
Now, our dataset includes Portfolio Indicators like Returns of the Portfolio, Risk-Free Rate, Beta, and Market Return. We can calculate Alpha using these parameters following the CAPM formula.
Now we need to calculate the Expected Rate of Return.
- Type the following formula in cell C11 and press ENTER to get the Expected Rate of Return.
- After that, type the following formula in cell C12 and hit ENTER to get the value of Alpha.
Hence, we’ve got the Alpha value. From the figure, we can see that Alpha is 3.41%.
4. Calculating Alpha for Portfolio of Multiple Securities
Now, we’ll calculate Alpha in Excel for another scenario. In this case, we’ve Portfolio Indicators like Market Return and Risk-Free Rate data. Also, we’re calculating Alpha for a portfolio of multiple securities. These securities include NYSE, Nasdaq, BSE and CHX. We have information like Returns, Beta, and Weight in Portfolio. We need to use these data to calculate the ultimate Alpha.
Our dataset looks like this.
We need to calculate the Portfolio Returns. This is the weighted summation of the Returns.
- Type the following formula in cell C16 and hit ENTER to calculate the Portfolio Returns.
Similarly, calculate Portfolio Beta.
- Type the following formula in cell C17 and hit ENTER to calculate the Portfolio Beta.
Lastly, calculate the Expected Rate of Return in the same fashion.
- Type the following formula in cell C18 and hit ENTER.
We’ll get the Expected Rate of Return in this way.
Finally, calculate Alpha by subtracting the Expected Rate of Return from the Portfolio Returns.
- Type the following formula in cell C19 and hit ENTER to do so.
We’ve got the Alpha value by following this method. The value is 0.25%.
Takeaways from This Article
If you’ve followed this article properly, you’ll be able to:
- Calculate Cronbach’s Alpha for any questionnaires.
- Compute Jensen’s Alpha for any portfolio.
Things to Remember
While you’re working on Alpha, you should be careful about some aspects.
- Use the COVARIANCE.P and VAR.P functions properly.
- Check the Anova settings thoroughly.
I’ve demonstrated how to calculate Alpha in Excel in this article. I’ve covered both Cronbach’s Alpha and Jensen’s Alpha in this article. Regarding C Alpha, you can use it in your own questionnaires now. I’ve shown possible real-life scenarios to do so. Again, we’ve calculated Alpha for single security and for multiple securities too. If you’ve followed this article thoroughly, I hope that you can use this knowledge to calculate Alpha by yourself. If you face any issues regarding that, please let us know in the comment section. Exceldemy will try to solve it for you. Have a good day!
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